Granting LLC membership units to employees upon sale or acqusition

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My company is an LLC incorporated in Massachusetts. We're looking for a way for our employees to participate in any upside if the company is sold or acquired. We don't want to award membership units now because that has tax consequences. For example, because LLCs are pass-through entities, owners pay taxes on company profits whether or not they receive distributions. That's just one issue. Another issue is each employee would have to sign the LLC's operating agreement. There are other issues as well.

To avoid these complications, we'd like to award units to employees only upon the sale or acquisition of the company. We're wondering how other people have solved this problem. We could convert the company to a corporation, but we'd prefer to keep the legal entity unchanged.

Are there any LLCs out there with a similar problem? How have you dealt with it?

2 Answers

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That's exactly what stock options are for. You can issue stock options to your employees. You will have to have a valuation expert determine the value of the company in order to set the strike price for these options (that valuation process costs about $7500). The strike price should be set at today's value. That way, the stock option grant itself has no tax implications. If the company is sold or acquired, employees exercise their options and benefit from the upside.

(NB: make sure you have an experienced lawyer prepare the stock option plan. Budget about $10,000 for this, plus the cost of the valuation.)

Thanks Joel, but I don't think stock options apply to LLCs, do they? Also, our intent is to award a set number of units to each employee outright upon a qualifying event like a sale or acquisition. We don't want folks to have to purchase them.
Finally, we don't want employees to incur any tax liabilities when the LLC generates profits in the meantime.
I have an email out to our accountant. I'll update folks when I get some feedback from him.
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Michael Monteiro8 years ago

Yes, they have stock options for LLCs, they just call them "Incentive Units." And... this is exactly how they work. People don't have to purchase them, and they don't incur tax liabilities.
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Joel Spolsky8 years ago

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I'm not familiar with a method to do that as an LLC. Perhaps look into an S corp, their filings are more complicated than the LLC but its still simple compared to a C corp and the struture is easier for moving to a C corp when attracting more VCs.